Advanced Accounting

Topics: Generally Accepted Accounting Principles, Goodwill, Depreciation Pages: 147 (11534 words) Published: October 28, 2013
CHAPTER 3
CONSOLIDATIONS—SUBSEQUENT TO
THE DATE OF ACQUISITION
Answers to Discussion Questions
How Does a Company Really Decide which Investment Method to Apply? Students can come up with literally dozens of factors that should be considered by Pilgrim in making the decision as to the method of accounting for its subsidiary, Crestwood Corporation. The following is simply a partial list of possible points to consider. Use of the information. If Pilgrim does not monitor its own income levels closely, applying the equity method would seem to be a waste of time and energy. A company must plan to use the additional data before the task of accumulation becomes worthwhile. Size of the subsidiary. If the subsidiary is large in comparison to Pilgrim, the effort required of the equity method may be important. Income levels would probably be significant. However, if the subsidiary is actually quite small in relation to the parent, the impact might not be material enough to warrant the extra effort.

Size of dividend payments. If Crestwood pays out most of its earnings each period as dividends, that figure will approximate equity income. Little additional information would be accrued by applying the equity method. In contrast, if dividends are small or not paid on a regular basis, a Dividend Income balance might vastly understate the profits to be recognized by the business combination.

Amount of excess amortizations. If Pilgrim has paid a significant amount in excess of book value so that annual amortization charges are quite high, use of the equity method might be preferred to show the effect of this expense each month (or whenever internal reporting is made). In this case, waiting until the end of the year and recording all of the expense at one time through a worksheet entry might not be the best way to reflect the impact of the expense.

Amount of intercompany transactions. As with amortization, the volume of transfers can be an important element in deciding which accounting method to use. If few intercompany sales are made, monitoring the subsidiary through the application of the equity method is less essential. Conversely, if the amount of these transactions IS significant, the added data can be helpful to company administrators evaluating operations. Sophistication of accounting systems. If Pilgrim and Crestwood both have advanced accounting systems, application of the equity method may be relatively simple. Unfortunately, if these systems are primitive, the cost and effort necessary to apply the equity method may outweigh any potential benefits.

The timeliness and accuracy of income figures generated by Crestwood. If the subsidiary reports operating results on a regular basis (such as weekly or monthly) and these figures prove to be reliable, equity totals recorded by Pilgrim may serve as valuable information to the parent. However, if Crestwood's reports are slow and often require later adjustment, Pilgrim's use of the equity method will provide only questionable results. McGraw-Hill/Irwin

Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
3-1

Answers to Questions
1.

a. CCES Corp., for its own recordkeeping, may apply the equity method to the investment in Schmaling. Under this approach, the parent's records parallel the activities of the subsidiary. Income will be accrued by the parent as it is earned by the subsidiary. Dividends paid by Schmaling cause a reduction in book value; therefore, the investment account is reduced by CCES in a corresponding manner. In addition, any excess amortization expense associated with the allocation of CCES's purchase price is recognized through a periodic adjustment. By applying the equity method, both the income and investment balances maintained by the parent accurately reflect consolidated totals. The equity method is especially helpful in monitoring the income of the business combination. This method can be, however, rather...
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